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| David McEwen's Investor Column | | David McEwen's Investor Column is syndicated nationally and is written on alternate weeks by David McEwen, CFO of Investment Research Group Ltd | | | | For archival copies of David McEwen's Investor Column click here... | | | | 10th July 2010 | THE END OF PUMP PRIMING
By David McEwen
One of the reasons why the Great Depression of the 1930s was so severe was that governments everywhere, including New Zealand, believed in balanced budgets.
The logic was impeccable. The traditional way anyone reacted to a decrease in income at the time was to cut costs accordingly. The alternative was to borrow, which was difficult because capital was scarce and few people liked doing it anyway because the penalty for non-repayment was destitution and public opprobrium. Within living memory, defaulters had been sent to debtor's prison.
Therefore, when times were hard, governments would introduce austerity budgets.
It was only after WWII that it became popular for governments to borrow and spend to stimulate their economies and make up for any decline in private sector demand.
This 'pump priming' mentality has reached a peak in the past couple of years, in response to the global financial crisis and ensuing recessions.
Certainly that approach has eased the pain, with markets recovering and recessions temporary and mild. It is not yet clear whether the real economy is ready to fill the gap as liquidity measures are withdrawn.
Despite this, governments everywhere are beginning to introduce austerity budgets. Generally this is not out of choice but is being forced upon them by crippling debt burdens.
While we might be able to shrug off budget cuts, with their ensuing shrinkage of economic growth, in minnows like Greece and Portugal, in recent times we have seen commitments to slash spending by economic powerhouses like Japan and the UK.
British finance minister Osborne has announced measures to cut the country's budget deficit, including slashing government spending, raising the Value Added Tax to 20% and imposing a levy on banks. The plan is to eliminate the UK budget deficit in five years' time.
Presumably after this the country will be in a position to make a dent in its public borrowings of more than $1.3 trillion. Incidentally, this debt has doubled since 2003.
In Japan, the government there has announced plans to cap its spending, increase taxes with a view to eliminating its budget deficit within 10 years. It needs to do something because its public debt is now over $10 trillion and, at 200% of GDP, is the highest in the world relative to income.
In Germany, Chancellor Angela Merkel has unveiled a major austerity package aimed at finding savings of more than $150 billion by 2014.
Its public debt totals $3 trillion.
France is raising its retirement age and taxes to rein in its deficit and deal with a public debt of $2 trillion.
New Zealand's debt burden is much more modest but the government has announced that it is looking to make cuts to spending.
This leaves the USA as the lone spendthrift, despite its public debt at a record $17 trillion or so. Meanwhile, emerging economic powerhouses of India and China appear in good health.
My point is that widespread budget cuts by many nations will remove billions and possibly trillions in total spending from the world economy. Since the fastest growing economies, mostly in Asia, depend on selling consumer goods to the west, the outcome can only be lower global GDP, reduced corporate profitability and, ultimately, lower asset prices.
David McEwen is chief investment officer of Investment Research Group Ltd www.irg.co.nz A disclosure statement is available at no charge upon request.
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